Coal: No 'Imminent Bankruptcy Risk' But UBS Discusses Anyway

By

Ben Levisohn

May 27, 2014 3:47 p.m. ET

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Pick a coal stock--any coal stock--and it's likely that those shares have been pounded this year. That's made some analysts consider whether they're cheap enough to buy. UBS thinks its time to consider bankruptcy, even if its not a near-term concern.

Bloomberg

How bad have the losses been this year? Peabody Energy (BTU) is down 9.5% so far in 2014, while Arch Coal (ACI) is off 16%. Alpha Natural Resources (ANR) has plunged 48% and WalterEnergy (WLT) had plummeted 66%.

UBS analyst Kuni Chen explains why now's a good time to start thinking about bankruptcy in the coal sector:

Since 2012, we have seen Patriot Coal and James River file for bankruptcy protection. There continues to be signs of mounting financial distress in the coal sector with some tranches of Walter paper trading at 60 cents on the dollar. Alpha and Arch paper is trading a bit better in the 70-80 range for unsecured debt. With yields approaching the mid-teens percentages for Arch Coal/Alpha Natural Resources paper, the bonds are edging closer to distressed levels. Meantime, the equities continue to be weak with Walter Energy down almost 70% in the last 12 months and Alpha Natural Resources down 40% vs. the S&P 500 +14%. While there does not appear to be any imminent bankruptcy risk, we want to discuss the potential event path to a next potential liquidity crisis looking ahead 2-3 years. Within our coverage universe, the companies with the most financial leverage include Alpha Natural, Arch Coal, and Walter Energy.

It's not like any of them are low on cash, however. Chen notes that Alpha Natural Rea sources and Arch Coal each have $1 billion in cash equivalents, while Walter Energy has $430 million. Chen says that's enough to last Alpha Natural Resources and Arch Coal three years, and Walter Energy has enough to last until the end of 2015. So what happens if that cash runs out? Not necessarily Chapter 11. Chen explains:

If companies deplete available cash, we expect credit lines to be drawn and more secured paper issued to the extent possible. In our view, Alpha, Arch, and Walter may not be good Chapter 11 restructuring candidates since debt comprises most of the long term liability pie. There may be limited ability to shed other liabilities through a restructuring process. Hence, it may make more sense for unsecured bondholders to do exchange offers or agree to other concessions out of bankruptcy. That said, companies with a larger amount of secured debt, like Walter, may be more inclined to go through a Chapter 11 process in anticipation of higher recoveries.

Chen also thinks it makes sense for Peabody Energy to sell more stock to pay down its big debt load:

We've been getting more questions from investors on whether Peabody may consider an equity raise. In our view, the arguments in favour of an equity raise make a lot of sense and give Peabody a clear way to tackle its $6B debt load without shedding assets. Balance sheet leverage is high but not disastrous at 8-9x net debt/EBITDA this year. In addition, Peabody's $4.8B market cap provides more flexibility to do an equity raise. For argument's sake, if Peabody did a $2B equity raise, net leverage would fall to a range of 4-5x and debt-to-capitalization would drop from 60% to the low 40% range. This would provide added flexibility to weather the downturn in the seaborne coal markets should prices stay at depressed levels for a longer than expected period of time. Contrary to some views, a recapitalization of the balance sheet probably does not provide substantial dry powder for Peabody to make acquisitions. However, if coal markets strengthen somewhat then the recapitalization could bring net leverage down to a reasonable 3-4x level by 2016.

Shares of Walter Energy have dropped 1.4% to $5.61 at 3:44 p.m. today, while Alpha Natural Resources has fallen 0.3% to $3.71 and Peabody Energy is unchanged at $17.22. Arch Coal has gained 1.1% to $3.73.

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